Morningstar® CEF Report™

Foreign & Colonial Investment Trust FRCL

Morningstar Analyst Report Fund Report for FSGBR04KGA Foreign and Colonial Investment Trust

by Jackie Beard, 11/01/12

Author can be reached at
Analyst Feedback

Morningstar's Take FRCL

Morningstar Analyst Rating™

Last Price

356.50

Current Discount

-10.72%

Last Actual NAV

396.14

Latest NAV Date

17/06/2013

Gross Gearing

113

Net Gearing

112

1 Year Z Stat.

0.42

Ongoing Charge (2012)

0.56%

Average Daily Shares Traded (1 Yr)

0.38m

Role in Portfolio

Core. The fund offers a well diversified portfolio comprising global equities and an element of private equity.

Executive Summary

Process: Tigue sets the asset allocation strategy for the fund and delegates stock selection to his appointed regional specialists.
NAV Performance: The fund's returns are better than its Morningstar category average under Tigue’s tenure over the short, medium, and long term.
People: Jeremy Tigue determines asset allocation and outsources stock selection to regional specialists at F&C; for North American large caps and private equity, external managers have been appointed.
Parent: Following a period of change F&C is in the process of redefining its identity.
Board: The board is hefty, at nine members; a number of directors have only recently joined.

Morningstar Opinion

Foreign & Colonial may be old, but it’s full of life.

Launched in 1868, this fund pioneered the way for collective investing as we know it today and not only has it survived, it still has much to offer.

With Jeremy Tigue of F&C at the helm since 1997, this fund has consistency of management that is rare to see, and that’s despite a number of changes at the corporate level as the parent firm has been acquisitive over the last decade. We’ve yet to see if the most recent deal, with Thames River, will bring stability among the ranks at last; there have been a number of fund manager and analyst departures from the firm in recent years.

That said, the impact of these departures on this fund has been limited. Tigue is responsible for asset allocation and he outsources stock selection to regional specialists. So turmoil among colleagues could have been a big negative; the European segment will be changing hands in early 2012 but the other segments managed by F&C staff are largely unscathed. In addition to colleagues, Tigue outsources to external managers for North American large caps and also private equity, in which this fund has around 20% (31 Dec 2011). The former is outsourced to two US firms and the latter to two private equity funds of funds.

This process has worked well and we like the use of external managers to plug the skills gaps. Tigue manages both asset allocation and gearing actively and isn’t afraid to make bold moves when his conviction is high. However, from hereon we’re likely to see less pronounced shifts as Tigue believes the emerging-markets story is largely played out, having been a big driver of returns in the last five years. The portfolio is very diverse, given the number of managers involved; at 30 Nov 2011 it had more than 570 individual positions. The fund places firmly in the large-cap segment of the Morningstar Style Box but it’s common to see some smaller-company exposure, particularly in North America where Tigue uses Robert Siddles, an in-house US small-cap specialist.

This approach has led to returns that comfortably beat the fund’s Morningstar Global Large-Cap Blend Equity category peers over the short, medium, and long term, though there are a number of global CEFs that have done even better. These returns have been achieved with risk kept in check, and that’s despite the use of gearing. There is fixed-term gearing here, but the nature of the gearing could be changing in 2014 when the debenture redeems. The board will then have to decide the new strategy.

The board is large, comprising nine members. We’re a little concerned that when the longest-serving director retires, the average tenure will be fairly short and some of the history will be lost. New chairman Simon Fraser has been proactive, though, and we like the changes made to the fee structure, namely the scrapping of the performance fee to keep costs low.

Portfolio Process Approach

Tigue is responsible for setting the asset allocation strategy in this fund and then he outsources stock selection to colleagues, or, in the case of North American large caps and private equity, to external managers. His strategy is determined through discussions with the regional teams at F&C, as well as his own views, and he also has access to output from the former parent insurance company Friends Provident. This link may disappear, though, given the change in ownership in 2009. Tigue isn’t afraid to take meaningful positions in his allocation strategy at times of conviction. For example, he closed down the developed Asia portfolio at the start of 2011 and reduced gearing as he wanted a more cautious stance in the fund. Tigue acknowledges that while asset allocation has been the biggest driver of returns in the last five years, it’s hard to see the next big theme on the same scale so there is more pressure to sharpen up stock selection. The regional managers blend top-down analysis with bottom-up fundamental screening in their respective universes, with a focus on valuation metrics such as economic value added. The managers have their own preferred metrics for analysis according to their respective markets. Tigue monitors the overall portfolio from a risk perspective to ensure the sector biases match his macro thinking.

Portfolio Positioning

The fund’s benchmark is 40% UK so it’s common to see at least one third of assets invested here. The private equity fund-of-funds portfolios have risen in value to around 20% (Dec 2011) from nearer 10% in 2002. Tigue expects this to reduce from hereon; it has taken longer for them to return cash as private equity transactions virtually dried up as a result of the financial crisis in 2008. 2011 saw this improve, hence his optimism. At 30 Nov, the fund had a modest overweight to emerging markets and an underweight to the US relative to the category average, although in reality most companies now have some of their earnings coming from EM countries, which distorts this a little. The portfolio has a pronounced large-cap bias, although it will include smaller companies at the margin in some regions, particularly the US. The total number of holdings is extremely diverse, given the way in which the fund is managed: At 30 Nov it comprised more than 570 individual stocks.

Dividends

Income is an important feature of this fund and the board aims to pay a rising dividend in absolute terms each year. It has achieved this for the last 40 years, an impressive record. The board dips into the revenue reserve account when needed: For example, this happened very recently in 2010. But the reserves have been built up over the years and there is a sufficient amount there to pay the dividend at its current level for more than two and a half years. Investors can take comfort in knowing, therefore, that their dividend will be maintained and thus it’s a source of income on which they can rely. Payments are made twice a year.

Discount

The fund tends to trade at a discount of around 10%. Its three-year average discount is 10.5% (31 Dec 2011), while on a shorter view of six months it’s 10.9%. It has been fairly range-bound since 2006 and sits in the middle of the pack when compared with Global Growth investment trust peers. The board aims to keep the discount at around 10%—a feat in which they have been successful—and they buy back shares regularly in the market. But they don’t operate under a hard discount control mechanism so they aren’t forced to buy shares back every time the discount breaches 10%.

NAV Performance Analysis

Under Tigue’s tenure from July 1997 to 31 Dec 2011, the fund has outperformed its Morningstar Global Large-Cap Blend Equity category by 2.5 percentage points on an annualised basis. It has also outperformed over one-, three-, five- and 10-year periods, to different degrees. It has tended to lose less in down markets without sacrificing returns in up markets, although 2008 was an exception. Compared with a smaller group of closed-ended peers, it has underperformed a majority of these peers since Tigue took charge, and most of them beat the Morningstar category average by a bigger margin than this fund. More recently, it fared well in 2011—while returns were negative overall, the fund lost considerably less than its category average and closed-ended peers.

Risk & Return

The fund has a risk profile that’s only slightly higher than its Morningstar category, when looking at its standard deviation (a statistical measure of risk) over the short and long term. Thus Tigue is using risk well to deliver returns that are superior to the fund’s category peers; this is despite the use of structural gearing in the fund. It tends to perform well in up markets and lose a little less in down markets, although in the shorter term it hasn’t fully participated in rising markets, as shown by its upside capture ratio. Nonetheless, it has still performed better overall than its category average.

Fees

Fees are very competitive at this fund and it has a definite cost advantage when compared with its Morningstar Global Large-Cap Blend Equity category median of 1.59%. From the start of 2011, F&C has been taking an annual management fee of 0.365% of the fund’s market capitalisation, on a monthly basis. There is no performance fee: This was scrapped in 2011 as a result of a board review of charges. This new arrangement replaced a fixed fee of GBP 6.7 million and two separate performance fees, which resulted in a higher TER. Fees will be revisited next by the board in 2014.

Gearing

The fund has two fixed-term debentures, of which the main loan (GBP 110 million) redeems at the end of 2014. There are also three currency loans in GBP and JPY as these were the cheapest facilities at the time. Thus it’s usual to see gearing in double digits, but it’s not static as Tigue manages it actively. For example, through 2008 gearing was scaled back as market volatility increased. Gearing decisions are Tigue’s alone to make but he does this after discussion with the board. Given the frequency of board meetings, it’s assessed and debated regularly. In 2014 the board will need to decide the future strategy for gearing, with the redemption of the fixed-term debenture. However, this should see a reduction in the cost of gearing as the debenture has an interest rate of 11.25%. One possible route is the use of derivatives.

People

Jeremy Tigue has had overall responsibility for the fund for the last 14 years. Tigue joined F&C in 1981 and has lived through a number of corporate changes at the firm. He is in charge of the fund’s asset allocation strategy, but he outsources stock selection to regional specialists at F&C; the exceptions here are North American large and mid-caps, which are sub-managed by Barrow Hanley and T Rowe Price, and private equity, which is sub-managed by Pantheon Ventures and HarbourVest Partners. He is deputised by Julian Cane, a member of the UK Large Companies team who is also in charge of picking equities for the UK portion of the fund. The pair have been colleagues since 1993. For emerging markets, he draws on EM team head Jeff Chowdhry, who has been with F&C since 1994; Japan investing is handled by team head Jamie Jenkins, who joined F&C in 2000—this came back in-house in 2010, having been managed by Goldman Sachs for five years; US smaller companies are picked by Robert Siddles, whose tenure at F&C dates back to 2001; responsibility for Europe is changing hands as Paras Anand is leaving the firm, so Sam Cosh takes up the mantle in early 2012. Despite the corporate changes at the firm in the last decade, the underlying managers have been relatively stable. Shareholders have the added benefit of the dedicated manager in Tigue, as this fund is his only charge. This is a specific request by the board.

Parent

F&C Investments is a business that has undergone considerable change over recent years following a series of acquisitions and mergers. The firm was formed out of a merger between ISIS and F&C Group in 2004. In July 2009 the business demerged from former parent Friends Provident and was listed on the London Stock Exchange. In Sept 2010, F&C acquired the investment boutique Thames River Capital and in early 2011, activist investor Sherborne built a significant stake in the business and embarked on a strategic review of the firm. As a result, F&C’s chairman Nick MacAndrew was ousted and significant cost-cutting measures were announced, impacting most notably on back-office operations. As a result of this change the business is in the process of redefining its identity. While Thames River has been fully integrated into the business, it has assumed responsibility for the firm’s retail distribution, which as at the end of Sept 2011 represented only 15% of the firm’s overall assets under management, which stood at GBP 103.2 billion. F&C’s AUM are still largely skewed toward fixed income, representing 60% of AUM, but the firm is focused on broadening its investment offering, most notably in UK equities.

Board Of Directors

The fund’s board is one of the biggest we’ve seen, comprising nine at 1 Jan 2012. Sir Michael Bunbury will be retiring in May 2012 after 14 years of service, after which time the longest tenure will be just six years. There have been several changes to the board in recent times: Six of the nine directors have been appointed only in the last three years. That’s quite a high level of turnover and when Sir Bunbury steps down that’s several years of the fund’s history that go with him. The breadth of the board helps to allay our concerns a little, but we prefer to see a wider mix of long and short tenures. The board has recently bolstered its investment management experience through the appointments of Sarah Arkle, former CIO of Threadneedle, and Nick Moakes, former Asian and emerging-markets equity director at BlackRock. It’s also encouraging to see that all nine directors are shareholders in the fund. The board meets at least 10 times each year on a formal basis, as well as ad-hoc informal meetings and an annual strategy meeting. Simon Fraser has only been in the chairman role since May 2010 and in the year of his appointment he hired an external consultant to help him review the board’s effectiveness. Hence, we’ve seen a number of recent changes such as the amendment to the fee structure, which should better serve investors.

Analyst Disclaimer Notes

Welcome to Morningstar.co.uk!

For more information: